Travelzoo Will Benefit from its Hotel Business as Search and Local Deals Suffer

Travelzoo is set to release its results for the second quarter of 2014 Thursday, July 17. The leading Internet media company, which has over 26 million subscribers, posted a 5% year-on-year decline in revenues in Q1, owing to weakness in its search and local deals businesses. Search revenues slumped by over 25% to $4.8 million as the company's investments into its new hotel booking platform had to be balanced by reducing the search marketing spend. On the other hand, local deals revenue decreased 21% to $6.9 million due to a decline in the number of deal vouchers sold. According to Travelzoo's management, the voucher format for deals is not suitable to many consumers as it is not a confirmed booking. A 6% year-on-year growth in travel-related revenue helped Travelzoo in partly absorbing the impact of lower Q1 search and local revenue. Travel generates more than 70% of the company's sales.

Travelzoo has brought new executives on board to devise the future strategy for search. At the beginning of the previous quarter, the company also appointed Mike Stitt as the new president of Travelzoo Local in North America. Mr. Stitt helped Travelzoo launch local deals in 2010 and will now help it in developing new deal formats that better suit customers. We expect to see continued weakness in search and local deals in Q2 as the company's efforts to revive the business will take time to ramp.

With the introduction of the hotel booking option on its websites this year in March, Travelzoo has marked a shift from its existing business model. The company had been developing the platform since Q3 2012 to reduce the friction associated with bookings. The hotel booking feature allows users to book quickly and easily within Travelzoo's websites and mobile products, thus also allowing suppliers to promote deals in a more flexible manner, For example, loading a last minute rate for a hotel will become much easier compared to Travelzoo's current solution, which redirects users to the hotel's website. The feature also helps Travelzoo to take advantage of peak season demand. Hotel room rates are higher during peak seasons and Travelzoo only offered off-peak season deals before the platform was launched.

Since revenue is recognized when the stay occurs and not when the booking occurs, the platform is expected to start generating revenue in the current half of the year. The company had already increased its headcount ahead of the platform's launch and will now start allocating more resources towards subscriber marketing. We believe that Travelzoo's entry in hotel bookings is a good long term strategy, as it opens up an additional revenue opportunity for the company. In our view, Travelzoo's growth will accelerate as the platform grows its scale by attracting more subscribers and advertisers. To learn more on how the hotel booking feature can drive Travelzoo's growth, read our article: Travelzoo's Hotel Booking Feature Can Help Drive Big Growth

Investments in building the hotel platform have negatively impacted Travelzoo's margins in recent quarters. For the full year 2013, the company's EBITDA margin fell by over 3 percentage points to 18.1%. Travelzoo spent $800,000 on the platform in Q1 2014 and expected to incur incremental costs to the tune of $1,100,000 in Q2. We believe these expenditures restrict the scope for margin expansion at this juncture.

Enhancing Presence in Mobile is Imperative to Revive Search Business

Travelzoo's search products include SuperSearch, a pay-per-click travel search tool, and Fly.com, a travel search engine that allows users to find the best prices on flights from different airlines and online travel agencies (OTAs). Fly.com completed the first full quarter of its mobile site in Q4 last year. It processed about 750,000 searches in its first quarter of business. However, it does not have any mobile app. This led the average number of monthly searches on Fly to decline from 3.5 million in 2012 to 3.3 million in 2013. The number of monthly searches on SuperSearch also plummeted from 5.1 million to 4.1 million contemporaneously, since the brand has neither a mobile app nor a mobile site.

SuperSearch and Fly also suffered because of the need to balance spending forced Travelzoo to decrease investments into search marketing. The company is currently focusing on driving profitable growth, which resulted in a revenue decline of about $1.5 million from SuperSearch in Q1. The company expects to witness a similar impact in its Q2 results. It has stated that the hotel platform will be its key focus area in 2014, and therefore, we think that it may not significantly invest in search marketing and building mobile search products to bolster growth.

About 66% of Travelzoo's revenues are generated in the U.S. Future growth in the U.S. search sector is expected to come from mobile. According to eMarketer, about 2% of the digital ad spending on search in 2010 occurred on mobile devices. This was expected to reach 22% last year, and eMarketer forecasts that the figure will cross the 50% mark by 2017. In line with this trend, search engines are increasing their focus on mobile devices to attract traffic. We believe that Travelzoo needs to heavily invest in building mobile products and modernizing its search offerings. The company has $61 million in cash on its balance sheet with no debt. It could utilize the cash or raise money through the debt channel to invest into mobile search.